With Bear Stearns, there was not an immediate impact on the banking system. And the fact that there was an arrangement to keep it going, it was not forced into bankruptcy, I think insulated the financial shock, the repercussions that you later saw with Lehman Brothers.

So actually from our perspective, we kind of knew that there was a lot of risk outside of the banks in the investment banks. They were much more highly leveraged, for one thing. One thing that is near and dear to the FDIC's heart is to have high capital standards and constraints on leverage for insured depository institutions. Excess leverage is always a vehicle for a lot of bad financial consequences. Because we want to keep banks healthy, because we insure their deposits, we are very strong advocates for high capital levels. ...

... Bear Stearns collapses, and there's an inherent distaste for what happened. Was it a bailout? Was it not a bailout? ... It becomes very hard to understand what Paulson is up to. ... I felt so much anger from friends and from listeners calling and e-mailing: "Oh, man, the fix is in. They're just helping their buddies stay rich. This is horrible."

I didn't think that was happening. I thought, Henry Paulson in his gut believes in capitalism and believes that you have to let bad institutions fail; that clearly he was spooked. But even then it still felt like maybe this was a one-off, that this was not the beginning of the systemic crisis. …

It's not that they were worthless like Lehman Brothers turned out to be; it's just that they couldn't get money to get them through that week. ... That was shocking, to see that it was basically a bank run, a shadow banking system bank run as opposed to the old bank run, where nobody is going to lend them money overnight because nobody wants to be the last guy to lend them money and lose it all. So seeing that speed and ferocity was definitely new. You picture more like a GM or a Ford, these huge companies dying over the course of decades, not hours. ...

I had actually met about six or eight months before with a new head of Bear Stearns. I heard there were problems there, but I had no idea the magnitude of them. And he had made a suggestion at the time. ... He wondered why the Federal Reserve Bank did not open the discount window to investment banks, subject them to the same regulatory requirements that member banks would be subjected to. That might be some way to sort of right this problem for investment banks at that hour. ...

We raised the issue with the Federal Reserve, asked them what they thought about that idea. They rejected it out of hand. The reason I tell you that is, of course, on that weekend coming up, you may recall that on that Thursday night before the Friday, when they went into this deal, they announced that they were going to open the discount window just to Bear Stearns, which was, in effect, a death sentence for them.

By Friday morning, of course, there was just a run on Bear Stearns. The thing collapsed -- the only one to get that treatment. Obviously the Fed was sending a message: This is an institution that's about to fail.

Because people could get their money out, they ran on it.

No other investment bank was getting the discount window open for them. So to single them out, in a sense, was to virtually assign them to a death sentence. And of course, that's what happened over that week. That Sunday night, of course, they announced they were opening the discount window for everybody, at least the other investment banks.

And my reaction at the time was, well, I hope this is the end of it. We put, I think, around $29 or $30 billion as a backstop to the federal government, that if this was the kind of message, this was going to send a shock wave through Wall Street, through Lehman Brothers and others: Get your act together; this is what can happen to you if you don't clean up your act and deal with your toxic instruments and the like.

And so like many at the time, I thought, well, I hope this is the end of it. I candidly felt we could have done a better deal. It seemed to me that in the $30 billion, what did we get for it? It's going to take a long time for these instruments to get healthy. In terms of us getting any kind of profitability out of them, the taxpayers would be in-lined with warrants, if that were the case.

The question I've asked myself since then, of course, a lot is, what were these people thinking about? ... Do you honestly believe only one of these investment banks are in trouble, the rest are not?

When you say "these people," who do you mean?

The Treasury. These are the people who we charge with the responsibility of monitoring. This is the Fed. These are the wizards. These are the guys who have the Ph.D.s and spent their lives looking at this, spent every working day, have huge staffs that monitor this. They're the ones who are supposed to keep [an eye] out for systemic risk in our country. That's their job every day. Why didn't someone -- maybe they did, but certainly not principals -- stand up and say, "Wait a minute; this is a lot bigger than Bear Stearns"? ...

What do you think the rationale was for saving Bear Stearns? Was there a valid argument to let them go?

No, I think these institutions -- and you're going to ask me about Lehman next -- these institutions are so interdependent that there are so many credit lines and credit-related instruments, like credit default swaps, out there that the failure of one of these institutions has very widespread repercussions. So the fact that they could prevent that in the case of Bear Stearns by getting JPMorgan to take over the entire balance sheet, all of the risks, except for a relatively small amount that the Fed agreed to take onto its balance sheet, was a sensible way of preventing what could have been a very harmful episode in the financial markets.

So the counterargument, which is let them go; let the market wash itself out?

This was letting the market work with a little help. In other words, this was not the government taking it onto its balance sheet; it was the government providing some relatively small piece of guarantee for a small part of the money that Morgan put up. So Morgan and its people went in and looked at the entrails of Bear Stearns, all of their assets, all of their liabilities, and said: "This is a good business, and it's worth our having. The assets exceed the liabilities, but there are some pieces of it that are very risky. Maybe it will all work out, but we'd like to have some guarantee on this" -- I think it was [the] $30 billion piece of it. And the Fed said, "Yes, that's worth it to us to provide that guarantee."

So far, months later, the Fed has recognized, I think, $2 billion of losses on that. The magnitude of the losses that could have occurred had they allowed Bear Stearns to fail could have been much, much bigger. ...

What you have here is, and people should understand, it wasn't that Bear Stearns was bailed out. The shareholders of Bear Stearns didn't do very well. It was -- and this was a pattern -- the creditors of Bear Stearns were bailed out.

What the administration recognized, I think correctly, was that because Bear Stearns was so indebted to so many other people, that their failure to repay their debt or pay their debt would cause a cascade of other failures, because people to whom Bear Stearns owed money wouldn't be able to pay the people they owed money to, etc. So there was this hope that that would stave it off.

This obviously kept getting worse and worse. It turned out that the proliferation of bad loans was greater than people realized. Housing prices were dropping faster than people realized. There were more defaults than people realized. So the inability to pay off creditors just spread.

My sense is that the Bear Stearns rescue actually engendered overconfidence. They did this thing. It was dramatic, but it seemed to work. The markets calmed down, and the various arcane measures that we all look at now to measure financial stress dramatically improved. And I think actually Larry Summers, [Treasury secretary, 1999-2001], said that Bernanke and Paulson had been the new committee to save the world. Remember back from the '90s, it was Summers and Greenspan and Rubin who were the committee to save the world. So there was the sense that, "Hey, we're on top of this thing, and we've got it working." So there was a false sense, delusions of competence, you might say, coming after the Bear Stearns rescue, because it seemed to be OK. ...